This is why Uber failed in China

When asked about Uber's attempt to dominate in the vast market
that is China, the CEO of homegrown ride-sharing company Didi
Chuxing, Jean Liu, said it was "cute."

Man was she right.

On Monday, Uber fled China. It surrendered a massive market and
sold its $8 billion business to Liu's Didi less than a week after
Chinese regulators legalized ride sharing in any capacity.

One would think that after three years of slugging it out for the
hearts of Chinese consumers, regulatory loosening would be the
time to ramp up efforts, regardless of the fact that Didi had 80%
of the country's market share.

The opportunity, after all, was well understood by investors. As
billionaire hedge fund manager Dan Loeb put it in his
second-quarter letter to investors:

"While ride‐sharing is rapidly gaining traction in numerous
markets around the world, we view China as a particularly
attractive market for ride‐sharing expansion thanks to several
differentiating factors. China has among the highest population
density levels of any large country and is home to nine of the
world's 30 largest cities. Ride‐sharing platforms tend to work
best in densely populated cities because they provide a liquid
supply of available drivers, consistent rider demand to attract
drivers, and correspondingly short waiting times.

"China also has a relatively low level of car ownership, with
only 130 vehicles per thousand people (vs 800 in the US and
500‐700 in Western Europe). Given chronic traffic in China’s
cities and the lack of available real estate for parking, a
mainstream culture of private car ownership in China has not yet
developed and most urban residents still rely heavily on public
transportation."

Of course, he explained this while he was telling his investors
about a new investment in Didi, not Uber. And it only takes a
basic understanding of what's going on in China right now to
understand his choice.

Capitalism with Xi Jinping characteristics

From the moment he took to the international stage, Xi Jinping
was a mystery. However, for the most part, we in the West thought
he would be much like his predecessors — open to foreign business
and ready to solidify China's central place in the global order
of capitalism.

Xi suggested as much in a speech in Washington, DC, after taking
power in 2013.

"China will never close its open door to the outside world.
Opening up is a basic state policy of China. Its policies that
attract foreign investment will not change, nor will its pledge
to protect legitimate rights and interests of foreign investors
in China, and to improve its services for foreign companies
operating in China," Xi said.

"We respect the international business norms and practice of
nondiscrimination, observe the … principle of national treatment
commitment, treat all market players — including foreign-invested
companies — fairly, and encourage transnational corporations to
engage in all forms of cooperation with Chinese companies."

You see, we had reason to believe that China's openness would
continue into the next administration.

Man were we wrong. Xi has turned out to be a new kind of Chinese
leader — an autocrat and an extreme nationalist, in a way that
extends past the Chinese military or even domestic politics.
These features extend to Chinese business.

In an August 2015 survey, the American Chamber of Commerce in
China found that only 25% of its members in the service sector
were optimistic about the regulatory environment in China. The
service sector, of course, includes banks, restaurants, and
companies like Uber.

The survey found that respondents were worried about the Chinese
government restricting key data-gathering efforts for foreign
companies, a lack of information about the rules of engagement or
regulatory procedures in the event of disputes, and an overly
broad definition of national security that applied to activities
American businesspeople never dreamed of.

This
is the industrial sector already in hard landing mode, a chart
Autonomous Research's brilliant China analyst Charlene Chu sent
to Business Insider in December.CEIC
and the National Bureau of Statistics; Charlene Chu, Autonomous
Research

"Numerous service industries in China face an uneven playing
field due to government support for state-owned enterprises and
designated oligopolies within their sectors. Such government
preferences, and the benefits the state-owned enterprises
receive, restrict both foreign and domestic companies' ability to
operate in the market," it said.

This might not just be a Xi thing, either. The Chinese economy is
going through the difficult transition of moving from an economy
based on industrial manufacturing and foreign investment to one
based on the services sector and domestic consumption.

One cannot be open and protectionist at the same time, but now
that industrial manufacturing is already in "hard landing" mode,
the government has to do everything it can to boost the services
sector. The economy is slowing, and the much-vaunted Chinese
Dream — the dream of economic progress that has consistently
trumped the nightmare of political repression — is at risk.

Tell me, who do you think you are?

Enter Uber, the Silicon Valley dynamo with a massive stockpile of
private money and a mission of world domination. For three years
it toiled in China, trying to gain market share in a fierce
battle with Didi. Or rather, it looked fierce from here in the
US. Again, apparently Didi thought the whole thing was "cute."

And that's likely because Didi understood the reality I just
outlined above. It is very telling that Uber did not.

"We were a young American business entering a country where most
US internet companies had failed to crack the code,” Uber CEO
Travis Kalanick said on Monday.

Many American companies are finding this code confusing, simple
though it may be. Meanwhile, Uber has made a habit of flouting
rules and norms. It has
run into multiple labor lawsuits here in America for
misclassifying its drivers as independent contractors rather than
employees. It was
chased out of Hungary.

And then there's this very
telling anecdote from former Fortress Investments President
Michael Novogratz, who met with the former CFO of Uber, Brent
Callinicos.

Callinicos told Novogratz that Uber drivers return between 20%
and 25% of the fares they collect, but that in the future, Uber
could easily raise that rate to between 25% and 30%. This would
drastically improve Uber's profit margin. Novogratz responded
quizzically.

"You've got happy employees, you've got happy customers, you've
got happy shareholders. The holy triumvirate are all really
excited about your company. Why are you going to risk that and
push the employee's salary down 5%?"

Callinicos simply responded, "because we can."

In China, it seems, you can't.

When the Chinese government legalized ride sharing, it included
provisions making it illegal to engage in a practice Uber has
become famous for — selling rides below cost to push out
competitors. It played this game with Didi, and Liu made fun of
Uber for it.

"Have you seen in other places market leaders buy market share?"
Liu said. "Normally it's always the smaller player with
smaller scale, lower efficiency, and in most cases worse service
that needs to buy market share to heavily subsidize."

President
Barack Obama stands with Chinese President Xi
Jinping.Reuters/Kevin
Lamarque

Dodging bullets

All of this said, it may very well be that Uber dodged a bullet
in China. The US internet companies that are getting left behind
as Chinese competitors take share may not be jealous for long.
The government has floated the idea of taking a 1% stake in
giants
like Tencent and Baidu to control what's on the web.

Of course, there's a darker way to look at that, and Wall
Street's all over it. As the Chinese economy slows and its
debt-to-GDP ratio (currently sitting at around 285%) grows, the
government is going to need places to find cash to keep money
flowing through already quasi-state-owned banks.

At a certain point, the entire economy starts to congeal, and
then you have a "Japanification" scenario. All of a sudden the
corporate sector is the government and the government is the
corporate sector, and any cash lying around has to do its part to
keep things going.

Uber, you didn't want to be involved in that mess anyway.

This is a column. The opinions and conclusions expressed above are those of the author.